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Stefan Hofrichter, Allianz’s Head of Global Economics & Strategy has developed 8 criteria to determine if an asset is in a price bubble. According to his evaluation “As a currency and asset class, bitcoin has potentially fatal flaws – which is why we believe it’s a matter of when, not if, the bitcoin bubble will pop. Yet the blockchain technology that powers cryptocurrencies could bring significant benefits to investors.”

[Ed note: Investing in cryptocoins or tokens is highly speculative and the market is largely unregulated. Anyone considering it should be prepared to lose their entire investment.]

A visual representation of the digital Cryptocurrency, Bitcoin. Photo Illustration by Chesnot/Getty Images

Asset bubble criteria

Of Hofrichter’s 8 criteria, I don’t think all of them apply to every asset bubble, but some definitely do for Bitcoin.

Another criterion is Overtrading. Bitcoin volumes have increased almost five times in the last five years. I would extend this to a rapid rise in an asset’s price. It seems a bubble is typically formed (but only visible in hindsight) when there is a swift upward price movement. The upward trend gets investors to pile in and the “greater fool theory” comes into play. Unfortunately, when there is a rush for the exits the price can drop like an elevator.

One criterion Hofrichter has is Significant Overvaluation, but I’m not sure how to apply it in this case. While this makes sense, a “concern” I have about using this regarding Bitcoin is what benchmark to value it. It doesn’t generate any revenue or profits, so traditional methods don’t work.

It does have a cost to create it, but that can vary significantly by what location is used to mine it. Most other assets have some valuation metric, but Bitcoin doesn’t seem to have one. Therefore it is hard to say it is overvalued.

Hofrichter added, “So is this the end of the hype about bitcoin as the future of global currencies? Probably not yet, since speculation in bitcoin and similar instruments appears set to continue for some time. Yet from our perspective, bitcoin has serious flaws: its trajectory resembles a textbook case of a financial-market bubble, and it is lacking several key qualities that would qualify it as a currency.”

Comparing Bitcoin to other bubbles

Hofrichter has compiled pricing for Bitcoin and 14 assets that have seen significant price appreciation followed by declines. They include various stock market and real estate timeframes along with Oil between 1975 and 1985, Gold between 1975 and 1982 and Tulip Mania from 1636-1637.

Hofrichter believes that Bitcoin’s intrinsic value is $0 because “a bitcoin is a claim on nobody – in contrast to, for instance, sovereign bonds, equities or paper money – and it does not generate any income stream.” This is very similar to Warren Buffett’s thinking on Bitcoin.

Hofrichter doesn’t believe that a Bitcoin meltdown will impact stocks and bonds since their “size” is still small, which is similar to my thoughts. And he believes that Blockchain technology has merits due to its ability to significantly reduce the costs of verifying transactions.